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The exchange traded fund industry has flourished over the years, however, of the 1,400 funds trading, assets are concentrated in a handful of funds. Most advisers use trading volume as a measure of liquidity, which limits the number of ETFs that are even considered in a portfolio.

“Clearly, advisers and wealth managers are avoiding some ETFs because they’re only looking at the trading volume,” said Reginald M. Brown, managing director of the ETF unit at Knight Securities Group, a trading platform that accounts for nearly 20% of all ETF trades. [What is an ETF? – Part 13: Trading Liquidity]

Currently, there are around 1,400 ETFs trading with more than two-thirds of the trading volume focused on these and about half of ETF industry assets concentrated in them, reports Jeff Benjamin for Investment News. [I’ve Seen the Future of ETFs]

Trading volume is an important attribute of an ETF, as lower activity equals wide spreads, higher costs, and possibly a lack of buyers when it is time to sell it. However, a more accurate interpretation of liquidity in ETFs would be to look at an ETF’s average trading volume and the average daily trading volume of underlying securities. ETF liquidity is based on everything that is inside the index or basket that the ETFs track since the funds are also shareholders of their underlying stock components.

Trading volume has been considered an indicator of an investments’ liquidity, but it is not an accurate way to measure the viability of an ETF. Doug Sandler, chief equity officer at RiverFront Investment Group LLC, said that what most advisers forget is that ETF liquidity is based not on trading volume but on the liquidity of the investments on which the ETF is based. [Why more Institutional Investors are Using ETFs]

The technical indicators that investors should focus on when selecting an ETF are the bid-ask spread, the liquidity of the underlying index and the intrinsic net asset value of the ETF, which represents the fair value of the underlying investment and is posted every 15 seconds throughout the trading day, according to Mike Eschmann, senior vice president at Direxion. [The Latest ETF Data on Liquidity]

“Some investors haven’t yet figured out that there are more important things to look at than trading volume, because they still view ETFs through the same lens of 10 years ago, when everything was homogenous, and all ETFs in the same category did pretty much the same thing,” Ryan Issakainen, senior vice president and ETF strategist at First Trust Advisors LP, said.

Tisha Guerrero contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.